Trends in Assets and Liabilities of Commercial Banks in the USA

Trends in Assets and Liabilities of Commercial Banks in the USA

To big to fail means too interconnected to fail.
As the balance sheets of banks have expanded so has their number of counterparties on both sides of balance sheets.

The US commercial banks have have expanded their balance sheets.

On assets side, the loans portfolio has expanded.

Low Interest Rates and Banks’ Profitability – Update October 2020

On liabilities side, the deposits and borrowings have increased.

US Federal Reserve publishes H8 report on Assets and Liabilities of the US commercial banks. Detailed information on aggregate data presented in this post can be obtained from it.

https://www.federalreserve.gov/releases/h8/h8notes.htm

On liabilities side, the borrowings from wholesale money markets and shadow banking contributed to systemic risk during 2008 financial crisis. Please see my posts on this subject.

Funding Strategies of Banks

Shadow Banking

There were also capital flows in US markets from foreign banks and other markets.

Low Interest Rates and International Capital Flows

On liabilities side, because of increased borrowings from short term markets, the financial interconnections have also increased resulting in systemic risk and financial contagion.

On assets side, because of increased volumes of loan portfolios, the systemic risk and chances for financial contagion have increased.

Balance Sheets, Financial Interconnectedness, and Financial Stability – G20 Data Gaps Initiative

Contagion in Financial (Balance sheets) Networks

For analytical framework, accounting approach (Post Keynesian Economics) is one of the option.

Balance Sheet Economics – Financial Input-Output Analysis (using Asset Liability Matrices) – Update March 2018

Foundations of Balance Sheet Economics

Economics of Money, Credit and Debt

Morris Copeland and Flow of Funds accounts

Stock-Flow Consistent Modeling

Key Terms

  • Money View
  • Money Flows
  • Stocks and Flows
  • System Dynamics
  • Business Dynamics
  • Business Strategy
  • Asset Liability Management ALM
  • Balance Sheet Economics
  • Monetary Policy
  • Interest Rates
  • Credit
  • Debt
  • Money
  • Balance Sheet Expansion
  • Systemic Risk
  • Interconnectivity
  • Loan Portfolio
  • To big to fail
  • Networks
  • Funding Strategy
  • Market Liquidity
  • Funding Liquidity
  • Deposits
  • Interest Income
  • Non Interest Income
  • Borrowings
  • Wholesale Money Markets
  • Shadow Banking
  • International Capital Flows
  • Round Tripping
  • Global Liquidity
  • Eurodollar Market
  • Money Market Mutual Funds
  • Quadruple Accounting
  • Morris Copeland
  • Hyman Minsky
  • Wynn Godley
  • Perry Mehrling

Image Source: Liberty Street Economics 2017

AVERAGE NET INTEREST MARGIN OF BANKS IN THE UNITED STATES FROM 1995 TO 2019
Image Source: Statista

NET INTEREST MARGIN FOR ALL U.S. BANKS (USNIM)
Image Source: FRED

Total Assets, All Commercial Banks (TLAACBW027SBOG)
Image Source: FRED

Total Liabilities, All Commercial Banks (TLBACBW027NBOG)
Image Source: FRED

DEPOSITS, ALL COMMERCIAL BANKS (DPSACBW027SBOG)
Image Source: FRED

My Related Posts

Balance Sheet Economics – Financial Input-Output Analysis (using Asset Liability Matrices) – Update March 2018

Foundations of Balance Sheet Economics

Balance Sheets, Financial Interconnectedness, and Financial Stability – G20 Data Gaps Initiative

Funding Strategies of Banks

Economics of Money, Credit and Debt

Low Interest Rates and International Capital Flows

Low Interest Rates and Banks’ Profitability – Update October 2020

Morris Copeland and Flow of Funds accounts

Key Sources of Research

Deposits, All Commercial Banks (DPSACBW027SBOG)

https://fred.stlouisfed.org/series/DPSACBW027SBOG

Total Liabilities, All Commercial Banks (TLBACBW027NBOG)

https://fred.stlouisfed.org/series/TLBACBW027NBOG

TOTAL ASSETS, ALL COMMERCIAL BANKS (TLAACBW027SBOG)

https://fred.stlouisfed.org/series/TLAACBW027SBOG

Between deluge and drought:
The future of US bank liquidity and funding

Rebalancing the balance sheet during turbulent times

McKinsey

2013

https://www.mckinsey.com/~/media/mckinsey/dotcom/client_service/Risk/Working%20papers/48_Future%20of%20US%20funding.ashx

Assets and Liabilities of Commercial Banks in the United States – H.8

https://www.federalreserve.gov/releases/h8/h8notes.htm

The geography of dollar funding of non-US banks1

The Dollar Shortage, Again! in International Wholesale Money Markets

The Dollar Shortage, Again! in International Wholesale Money Markets

 

During the 2008-2009 global financial crisis, There were many European Banks which got into trouble due to shortage of US Dollar funding in the whole sale international interbank market.  US Federal Reserve eventually extended currency swaps to ECB and other central banks to ease the pressure.

Is it happening now?  There is no banking crisis but there seems to be Dollar Shortage.

 

Foreign Exposure of European Banks

Liquidity Constraints in Global Money Markets (International Interbank Market)

  • Eurodollar Market

Non US Borrowers got funding from FX Market

  • FX Swap
  • Currency Swap

and Non Bank Sources (Shadow Banking)

  • MMMF
  • ABCP

 

Funding and liquidity management

Funding can be defined as the sourcing of liabilities. Funding decisions are usually, but not exclusively, taken in view of actual or planned changes in a financial institution’s assets. The funding strategy sets out how a bank intends to remain fully funded at the minimum cost consistent with its risk appetite. Such a strategy must balance cost efficiency and stability. A strategy which targets a broader funding base may entail higher operating and funding costs, but through diversity provides more stable, reliable funding. One which focuses efforts on generating home currency funding may prove more reliable in adverse times but entail higher costs in normal markets. The balance of cost and benefit will reflect a range of factors (see Section 3). Accordingly, funding risk essentially refers to a bank’s (in-)ability to raise funds in the desired currencies on an ongoing basis. Liquidity management is the management of cash flows across an institution’s balance sheet (and possibly across counterparties and locations). It involves the control of maturity/currency mismatches and the management of liquid asset holdings. A bank’s liquidity management strategy sets out limits on such mismatches and the level of liquid assets to be retained to ensure that the bank remains able to meet funding obligations with immediacy across currencies and locations, while still reflecting the bank’s preferred balance of costs (eg of acquiring term liabilities or holding low-yielding liquid assets) and risks (associated with running large maturity or currency mismatches). Accordingly, liquidity risk refers to a bank’s (in-)ability to raise sufficient funds in the right currency and location to finance cash outflows at any given point in time. Funding and liquidity management are interrelated. Virtually every transaction has implications for a bank’s funding needs and, more immediately, for its liquidity management. The maturity transformation role of banks renders them intrinsically vulnerable to both institution-specific and market-related cash flow risks. The likelihood of an unexpected cash-flow shock occurring, and a bank’s ability to cope with it, will reflect not only the adequacy of its funding and liquidity management strategies, but also their coherence under stressed conditions. A bank’s funding strategy will condition liquidity management needs. Hence, the risks embedded in the chosen funding strategy will translate into risks that liquidity management will have to address. Failure to properly manage funding risk may suddenly manifest itself as a liquidity problem, should those sources withdraw funding at short notice. Conversely, inadequate liquidity risk management may place unmanageable strains on a bank’s funding strategy by requiring very large amounts of funding to be raised at short notice.

 

From The Global Financial Crisis and Offshore Dollar Markets

The Global Shortage of U.S. Dollars

International firms need U.S. dollars to fund their investments in U.S.-dollar-denominated assets, such as retail and corporate loans as well as securities holdings. The funding for these investments is typically obtained from a variety of sources: the unsecured cash markets, the FX swap market, and other shortterm wholesale funding markets.

During the financial crisis, a global shortage of dollars occurred, primarily reflecting the funding needs of European banks. Baba, McCauley, and Ramaswamy (2009) show that European banks had substantially increased their U.S. dollar asset positions from about $2 trillion in 1999 to more than $8 trillion by mid-2007. Until the onset of the crisis, these banks had met their funding requirements mainly by borrowing from the unsecured cash and commercial paper markets and by using FX swaps. Unfortunately, most unsecured funding sources eroded during the crisis. For example, U.S. money market funds abruptly stopped purchasing bank-issued commercial paper after they faced large redemptions associated with the bankruptcy of Lehman Brothers (Baba, McCauley, and Ramaswamy 2009). The reduced availability of dollars resulted in higher dollar funding costs.

The remainder of this article describes the increase in dollar funding costs as reflected in the FX swap market, the primary market enabling global financial institutions to manage multi- currency funding exposures without assuming the credit risk inherent in unsecured funding markets. As liquidity in major unsecured lending markets eroded, the demand for dollar funding through FX swap markets intensified sharply and pushed up the cost of raising dollars through FX swaps. Moreover, heightened demand for dollar funding in conjunction with a reduced willingness to lend dollars noticeably impaired the functioning of the FX swap market, particularly as term liquidity dried up.

 

Measures of Liquidity Tightening

  • LIBOR-OIS Spread
  • FX Swap implied basis spread

 

Two Measures

Two measures are used to show the increased cost of dollar funds in private markets during the crisis.

  • The first is the spread between the London interbank offered rate (Libor) and the overnight index swap (OIS) rate.
  • The second measure is the foreign exchange (FX) swap implied basis spread, which reflects the cost of funding dollar positions by borrowing foreign currency and converting it into dollars through an FX swap.

 

 

dollarshort2

 

 

What are the Money Markets

Wholesale money markets

  • Unsecured cash term deposits and loans
  • Money market calculations and conventions
  • Benchmark rates and their determination
  • Libor
  • Euribor
  • Overnight indexed rates such as Eonia and Sonia
  • Treasury bills (a first look at risk-free)
  • Commercial Paper – CP credit ratings
  • Secured money market loans – sale and repurchase agreements (Repos)

 

Money market derivatives

  • Short term interest rate futures (STIRs): Eurodollar, Short Sterling and Euribor futures
  • Forward rate agreements
  • Interest rate swaps
  • Overnight index swaps (OIS): Sonia and Eonia swaps
  • Monetary policy and the money markets

How a central bank uses money markets to transmit its interest rate intentions.

 

 

OTC US Dollar Money Markets:  Sources of short term Funding

A.  Fed Funds Market (Domestic)

B.  Interbank Money Market

  • Cash Market
  • Market for Short Term Securities
  • Market for Derivatives

Cash Market

  • Unsecured – Eurodollar
  • Secured – REPO
  • Secured (Collateralized markets) – FX Swap Market

Short Term Securities Market

  • T-Bills
  • Commercial Paper
  • Certificate of Deposits

Derivatives Market

  • Interest Rates Swaps

 

 

Money Markets in EU

In the unsecured market, activity is concentrated on the overnight maturity segment. The reference rate in this segment is the Eonia (Euro Overnight Index Average). It is a market index computed as the weighted average of overnight unsecured lending transactions undertaken by a representative panel of banks. The same panel banks contributing to the Eonia also quote for the Euribor (Euro Interbank Offered Rate). The Euribor is the rate at which euro interbank term deposits are offered by one prime bank to another prime bank. This is the reference rate for maturities of one, two and three weeks and for twelve maturities from one to twelve months.11

The market for short term securities includes government securities (Treasury bills) and private securities (mainly commercial paper and bank certificates of deposits).

In the market for derivatives, typically interest rate swaps and futures are traded.

 

Is it happening again?

Policy Decisions such as

  • Rising Interest Rates
  • Stronger Dollar
  • Repatriation of Corporate profits from Europe
  • Unwillingness to extend of CB Swap Lines

can cause liquidity crisis which show up in

  • LIBOR rate
  • Eurodollar rate
  • OIS Rate
  • CIP breakdown
  • EURIBOR
  • TIBOR

 

Breakdown of CIP – Then and Now

 

dollarshort4

 

A brief history of the three key periods of global USD-funding shortfalls:

  • The first episode immediately after the Lehman bankruptcy coincided with a US banking crisis that quickly became a global banking crisis via cross border linkages. Financial globalization meant that Japanese banks had accumulated a large amount of dollar assets during the 1980s and 1990s. Similarly European banks accumulating a large amount of dollar assets during 2000s created structural US dollar funding needs. The Lehman crisis made both European and Japanese banks less creditworthy in dollar funding markets and they had to pay a premium to convert euro or yen funding into dollar funding as they were unable to access dollar funding markets directly.
  • The second episode of very negative dollar basis took place during the Euro debt crisis. The sovereign crisis created a banking crisis making Euro area banks less worthy from a counterparty/credit risk point of view in dollar funding markets. As dollar funding markets including fx swap markets dried up, these funding needs took the form of an acute dollar shortage. European banks and companies that had dollar assets to fund had to pay a hefty premium in fx swap markets to convert their euro funding into dollar funding. Those European banks and companies that were unable to do so, were forced to liquidate dollar assets such as dollar denominated bonds and loans to reduce their need for dollar funding
  • The third phase of very negative dollar basis started at the end of last year. Monetary policy divergence has for sure played a role during the end of 2014 and the beginning of this year. The ECB’s and BoJ’s QE has created an imbalance between supply and demand across funding markets. Funding conditions have become a lot easier outside the US with QE-driven liquidity injections raising the supply of euro and yen funding vs. dollar funding. This divergence manifested itself as one-sided order flow in cross currency swap markets causing a decline in the basis. And we did see these funding imbalances in cross border corporate issuance.

 

Emergent and Related Issues:

  • Global Liquidity
  • Offshore Dollar Money Markets
  • Eurodollar Market
  • International Lender of Last Resort
  • FX Swaps and Currency Swaps Market
  • Cross border funding
  • International Interbank Market
  • Shadow Banking – MMMF, ABCP,
  • LIBOR EURIBOR TIBOR
  • Covered Interest Parity (CIP) Breakdown
  • OIS LIBOR
  • Wholesale Funding Market
  • Global Credit
  • Credit Markets
  • Impact of Global Liquidity on Global Trade
  • Credit Networks of Global Banks
  • International Investment Positions of Banks
  • Derisking by global banks
  • Decline in Correspondent Banking
  • Shortage of Trade Finance

 

Why has Global Trade dropped so precipitously since 2014?

Is it because of shortage of US Dollars?

 

fx17

 

 

Key Sources of Research:

 

“This Is An Extremely Serious Problem” – Dollar Funding Shortage Hits Record In Japan

2016

http://www.zerohedge.com/news/2016-03-17/extremely-serious-problem-dollar-funding-shortage-hits-record-japan

 

 

Global Dollar Shortage Intensifies To Worst Level Since 2012

2015

http://www.zerohedge.com/news/2015-10-03/global-dollar-funding-shortage-intesifies-worst-level-2012

 

 

Dollar Illiquidity Getting Critical: A $10 Trillion Short Which The Fed Does Not Understand

2016

http://www.zerohedge.com/news/2016-11-16/dollar-illiquidity-getting-critical-10-trillion-short-which-fed-does-not-understand

 

 

The VIX Is Dead: According To The BIS, This Is The New “Fear Indicator”

2016

http://www.zerohedge.com/news/2016-11-15/vix-dead-according-bis-new-fear-indicator

 

 

New ICC survey finds worsening global shortage of trade finance

http://www.fx-mm.com/52872/news/trading-news/icc-survey-trade-finance/

 

 

 

A ‘dollar shortage’ has returned. This is why

2016

https://www.weforum.org/agenda/2016/10/a-dollar-shortage-has-returned-this-is-why

 

 

Dollar shortage *alert* (plus global trade *alert*)

2016

https://ftalphaville.ft.com/2016/11/15/2179675/dollar-shortage-alert-plus-global-trade-alert/

 

 

As goes correspondent banking, so goes globalisation

2016

https://ftalphaville.ft.com/2016/07/26/2170875/as-goes-correspondent-banking-so-goes-globalisation/

 

 

How do you solve a problem like de-globalisation?

2015

https://ftalphaville.ft.com/2015/09/24/2140786/how-do-you-solve-a-problem-like-de-globalisation/

 

 

On the ongoing demise of globalisation

2016

https://ftalphaville.ft.com/2016/10/11/2177071/on-the-ongoing-demise-of-globalisation/

 

 

Textbook defying global dollar shortages

2016

https://ftalphaville.ft.com/2016/06/09/2165690/textbook-defying-global-dollar-shortages/

 

 

The Coming Dollar Shortage

https://dailyreckoning.com/coming-dollar-shortage/

 

 

Dollar Shortage Goes Mainstream: When Will The Fed Confess?

2016

http://www.zerohedge.com/news/2016-11-24/dollar-shortage-goes-mainstream-when-will-fed-confess

 

 

The Global Dollar Funding Shortage Is Back With A Vengeance And “This Time It’s Different”

2015

http://www.zerohedge.com/news/2015-03-08/global-dollar-funding-shortage-back-vengeance-set-surpass-lehman-crisis-levels

 

 

The US dollar has been on a tear, and that will spell bad news for the rest of the world

http://markets.businessinsider.com/currencies/news/The-US-dollar-has-been-on-a-tear-and-that-will-spell-bad-news-for-the-rest-of-the-world-1001611294

 

 

There is a war for capital coming, says UBS

2016

https://ftalphaville.ft.com/2016/02/25/2154339/there-is-a-war-for-capital-coming-says-ubs/

 

 

The eurodollar as an economic no-man’s land

2016

https://ftalphaville.ft.com/2016/04/08/2158883/the-eurodollar-as-an-economic-no-mans-land/

 

 

 

Eurodollars, China, TIC data + mysteries

2016

https://ftalphaville.ft.com/2016/03/31/2157947/eurodollars-china-tic-data-mysteries/

 

 

Petrodollars are eurodollars, and eurodollar base money is shrinking

2016

https://ftalphaville.ft.com/2016/01/25/2151037/petrodollars-are-eurodollars-and-eurodollar-base-money-is-shrinking/

 

 

All about the eurodollars

2014

https://ftalphaville.ft.com/2014/09/05/1957231/all-about-the-eurodollars/

 

 

A global reserve requirement for all those eurodollars

2016

https://ftalphaville.ft.com/2016/04/15/2159277/a-global-reserve-requirement-for-all-those-eurodollars/

 

 

On the availability of dollar funding

2015

https://ftalphaville.ft.com/2015/04/01/2125661/on-the-availability-of-dollar-funding/

 

 

The dollar shortage problem, evaluated

2009

https://ftalphaville.ft.com/2009/08/05/65406/the-dollar-shortage-problem-evaluated/

 

 

All about the eurodollars, redux

2015

https://ftalphaville.ft.com/2015/09/24/2140580/all-about-the-eurodollars-redux/

 

 

BIS says we should follow the money

2014

https://ftalphaville.ft.com/2014/09/04/1955881/bis-says-we-should-follow-the-money/

 

 

Eurodollars, FX reserve managers and the offshore RRP issue

2015

https://ftalphaville.ft.com/2015/09/01/2139085/eurodollars-fx-reserve-managers-and-the-offshore-rrp-issue/

 

 

The BoE as eurodollar dealer of last resort?

2015

https://ftalphaville.ft.com/2015/02/20/2119663/the-boe-as-eurodollar-dealer-of-last-resort/

 

 

FT:  The Eurodollar Market: It All Starts Here

2016

http://www.zerohedge.com/news/2016-12-04/eurodollar-market-it-all-starts-here

 

 

From turmoil to crisis: dislocations in the FX swap market before and after the failure of Lehman Brothers

N Baba

http://www.bis.org/publ/work285.htm

 

 

Dollar Funding and Global Banks

Jeremy C. Stein

2012

 

Click to access stein20121217a.pdf

 

 

The US dollar shortage in global banking and the international policy response

by Patrick McGuire and Götz von Peter

October 2009

 

Click to access work291.pdf

 

 

The US dollar shortage in global banking

 

Patrick McGuire Goetz von Peter

2009

Click to access treasury_1196.pdf

 

 

 

Emergent International Liquidity Agreements: Central Bank Cooperation after the Global Financial Crisis

Daniel McDowell

 

Click to access mcdowell_eln.pdf

 

 

The Financial Crisis through the Lens of Foreign Exchange Swap Markets

Crystal Ossolinski and Andrew Zurawski

2010

 

Click to access bu-0610-7.pdf

 

 

The spillover of money market turbulence to FX swap and cross-currency swap markets

N Baba

2008

 

Click to access r_qt0803h.pdf

 

 

Liquidity Shocks, Dollar Funding Costs, and the Bank Lending Channel During the European Sovereign Crisis

Ricardo Correa, Horacio Sapriza, and Andrei Zlate

2012

 

Click to access ifdp1059.pdf

 

 

GLOBAL INTEGRATION OF BANKING MARKETS: AT WHAT COST?

John L. Simpson

 

Click to access 00463515e5285b6a85000000.pdf

 

 

Systemic risk in the major Eurobanking markets: Evidence from inter-bank offered rates

J.L. Simpson, J.P. Evans

2005

 

Click to access jou2-2.pdf

 

 

The Eurocurrency interbank market: potential for international crises?.

Saunders, Anthony.

Business Review (1988): 17-27.

 

 

The Great Liquidity Freeze: What Does It Mean for International Banking?

Dietrich Domanski and Philip Turner

June 2011

 

Click to access adbi-wp291.pdf

 

 

The Euro-dollar market as a source of United States bank liquidity

Steve B. Steib

 

http://lib.dr.iastate.edu/cgi/viewcontent.cgi?article=6277&context=rtd

 

 

The LIBOR Eclipse: Political Economy of a Benchmark

Alexis Stenfors1 and Duncan Lindo

January 2016

Click to access RMF-47_Stenfors-Lindo.pdf

 

 

Basics of U.S. Money Markets

2016

 

Click to access 05.10.2016-moneymarkets-9.15am.pdf

 

 

Implementing Monetary Policy – Short-term Money Markets Monitoring

2015

 

Click to access 09.29.2015-mmarketsv2-1.30pm.pdf

 

 

The Dollar Squeeze of the Financial Crisis

Jean-Marc Bottazzia Jaime Luqueb

Mario R. Pascoac Suresh Sundaresand

 

Click to access 6611902.pdf

 

 

Central Bank Dollar Swap Lines and Overseas Dollar Funding Costs

 

 

 

 

The Global Financial Crisis and Offshore Dollar Markets

Niall Coffey, Warren B. Hrung, Hoai-Luu Nguyen, and Asani Sarkar

2009

 

https://papers.ssrn.com/sol3/papers2.cfm?abstract_id=1496407

 

 

 

When and how US dollar shortages evolved into the full crisis?: Evidence from the cross-currency swap market

Naohiko Baba* and Yuji Sakurai†

10/27/2009

Click to access sem_paper_0_349_naohiko-baba.pdf

 

 

 

 

Funding patterns and liquidity management of internationally active banks

 

http://www.bankingreview.nl/download/23711

 

 

The functioning and resilience of cross-border funding markets

2010

CGFS 37

Click to access cgfs37.pdf

 

 

 

The Impact of the Financial Crisis on Cross-Border Funding

Yaz Terajima, Harri Vikstedt, and Jonathan Witme

2011

 

Click to access fsr-0610-terajima.pdf

 

 

Financial Crises and Risk Premiums in International Interbank Markets 

Shin-ichi Fukuda

Mariko Tanaka

 

Click to access ppr020f.pdf

 

 

Dollar Funding and the Lending Behavior of Global Banks

Victoria Ivashina

David S. Scharfstein

Jeremy C. Stein

October 2012

Click to access dollar_funding_october_2012_final.pdf

 

 

Financial crises and bank funding: recent experience in the euro area

by Adrian van Rixtel and Gabriele Gasperini

March 2013

 

Click to access work406.pdf

 

 

The Financial Crisis and Money Markets in Emerging Asia

Robert Rigg and Lotte Schou-Zibell

No. 38 | November 2009

 

Click to access wp38-financial-crisis-money-markets.pdf

 

 

Money Market Integration

Leonardo Bartolini Spence Hilton Alessandro Prati

 

Click to access sr227.pdf

 

 

Segmentation in the U.S. Dollar Money Markets During the Financial Crisis

James J. McAndrews

May 19, 2009

 

Click to access Session2.pdf

 

 

Re-thinking the lender of last resort

September 2014

 

Click to access bispap79.pdf

 

 

Towards an International Lender of Last Resort

Stephen G. Cecchetti

September 2014

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2504732

 

 

Global Liquidity: Public and Private

Jean-Pierre Landau

 

 

The Global Dollar System

Stephen G Cecchetti

Click to access Polp61.pdf

 

 

US dollar money market funds and non-US banks

Naohiko Baba Robert N McCauley Srichander Ramaswamy

2009

 

Click to access r_qt0903g.pdf

 

 

Improving the Resilience of Core Funding Markets

2009

Bank of Canada

Jean-Sébastien Fontaine, Jack Selody, and Carolyn Wilkins

 

 

How do Global Banks Scramble for Liquidity? Evidence from the Asset- Backed Commercial Paper Freeze of 2007*

by Viral V. Acharya Gara Afonso Anna Kovner

October 24, 2012

 

 

The Financial Crisis and Money Markets in Emerging Asia

Robert Rigg and Lotte Schou-Zibell

No. 38 | November 2009

 

 

Regulatory Reforms and the Dollar Funding of Global Banks:

Evidence from the Impact of Monetary Policy Divergence

Tomoyuki Iida

Takeshi Kimura

Nao Sudo

2016

 

Click to access wp16e14.pdf

 

 

Monetary policy spillovers and currency networks in cross-border bank lending

by Stefan Avdjiev and Előd Takáts

March 2016

 

Click to access work549.pdf

 

 

FUNDING LIQUIDITY RISK AND DEVIATIONS FROM INTEREST-RATE PARITY DURING THE FINANCIAL CRISIS OF 2007-2009

Prepared by Cho-Hoi Hui, Hans Genberg and Tsz-Kin Chung

2009

 

Click to access HKMAWP09_13_full.pdf

 

 

Deviations from Covered Interest Rate Parity

Wenxin Du  Alexander Tepper  Adrien Verdelhan

January 1, 2016

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2768207

 

 

Limits to Arbitrage and Deviations from Covered Interest Rate Parity

James Pinnington1 and Maral Shamloo

Click to access sdp2016-4.pdf

 

 

Capital Constraints, Counterparty Risk, and Deviations from Covered Interest Rate Parity

Niall Coffey Warren B. Hrung Asani Sarkar

September 2009

Click to access sr393.pdf

 

 

Covered interest parity lost: understanding the cross-currency basis

Claudio Borio Robert McCauley Patrick McGuire Vladyslav Sushko

2016

Click to access r_qt1609e.pdf

 

 

Bye-bye covered interest parity

Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko

28 September 2016

http://voxeu.org/article/bye-bye-covered-interest-parity

Bring back M3 – Monetary Aggregate

Bringback M3 even if it does not include all of Shadow Money and Eurodollars.

The crisis of 2008-9 was partly due to run on Repos.  But Fed Reserve had no visibility in this market.  Because Fed had discontinued reporting M3 in 2006.

From Death of M3 : The fifth anniversary.

Five years ago, in November 2005, the Federal Reserve announced that it would no longer be tracking the aggregate money supply. It issued a terse, cryptic 143-word press release entitled the “Discontinuance of M3.” M3 was the broadest member of the big 4 of monetary aggregates published by the Fed — M0, M1, M2, and M3 that the Fed had compiled monthly since 1959.

John Williams of Shadowstats noted the oddity of the announcement, opining that M3 was probably the most important statistic produced by the Fed and the best leading indicator of economic activity and inflation. The Fed’s lack of interest in the components of M3 can be directly linked to its inability to foresee the 2008 collapse of the financial system.

The American fiat, credit-money system starts with the Fed-supplied monetary base and pyramids upward through commercial banks, investment banks, offshore banks, nonbanks, and other credit providing entities. The “Ms” provide the Fed’s calculation of the money levels at different tiers of the credit pyramid to the markets.

With this decision, $3.3 trillion (the difference between M3 and M2) effectively disappeared off the Federal Reserve and the market’s radar screen. The Fed also stated that it would cease publication of Eurodollar, Repo, and institutional time-deposit data, though some intrepid analysts reconstruct this data by taking snapshots of the Fed’s balance sheet.

The two now-missing components of M3, Eurodollars and repos, are the “Wild West” of the money supply. Eurodollars are US dollar deposits held by non-US banks in places like London, the Bahamas, the Cayman Islands, and Iceland (while it lasted). They are not subject to US regulations and therefore can be levered up, free of reserve or reporting requirements. Eurodollar banks have been known to operate at 50:1 leverage ratios.

Repos are short-term, often overnight, loans made to financial companies that are collateralized by securities in the possession of the borrowing company. They are a critical financing source for investment-bank trading and lending businesses. In the early years of the repo market, the primary collateral was US Treasury Securities. Today, the primary collateral consists in complex derivative securities, such as asset-backed securities (RMBS/CMBS/ABS), collateralized loan obligations (CLOs), and collateralized derivative obligations (CDOs). Repos are also not subject to reserve or reporting requirements, leading to high leverage ratios in investment banks (e.g., Lehman Brothers at 30:1).

“If the Fed had been tracking repos in 2007–2008, what they would have seen was the unfolding of the financial crisis one full year before it went critical.”

M3 was a highly imperfect statistic in that it did not capture the full extent of the leverage. On Eurodollars, M3 only included Eurodollar deposits held by American bank holding companies. Given that the vast majority of Eurodollar activity takes place overseas through foreign banks, this is analogous to monitoring the global oil supply by sampling production data out of Alaska. On repos, the Fed only tracked repos beween itself and its primary dealers. According to Yale economists Gary Gorton and Andrew Metrick, there are no official statistics on the overall size of the repo market. They estimate that the Fed’s balance sheet could account for only $4.5 trillion of the overall $12 trillion repo market in 2008, making it even larger than the $10 trillion in assets in the US banking system.1 In other words, the repo market is bigger than the US banking system, but is unaccounted for by the Fed.

10004 table_0

If the Fed had been tracking repos in 2007–2008, what they would have seen was the unfolding of the financial crisis one full year before it went critical. From Q3 2007 through Q2 2008, the repo market was starting to seize with lenders starting to demand higher and higher haircuts on collateral. In early Q1 2008, Shadowstats estimates that the rate of M3 growth started to decline rapidly as repo activity cooled. Then in September 2008, the repo market decided that it was unwise to lend additional funds to Lehman Brothers and the rest is history.

Let us now return to the curious press release of November 10, 2005. The Fed explained its decision to stop collecting and publishing the data as follows:

On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. … M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.

The Fed’s statement boils down to three reasons for the discontinuance:

  • M3 does not provide additional information. This statement would only be true to an economist who believed that the aggregate money supply was unimportant.
  • M3 does not play a role in monetary policy. As Bernanke has now shown through various money-printing initiatives — QE1, QE2, TARP, TALF, etc. — he is truly unconcerned with the aggregate money supply and therefore it does not play a role in monetary policy.
  • M3 is too expensive to collect. The Fed estimated that it spent $500,000 per year to collect the data and banks spent $1,000,000 in aggregate to provide the data. This expense is not even a rounding error against the $21.5 billion in (paper) profit that the Fed reported in 2005.

November 2005 was the interregnum between the long tenure of Alan Greenspan and newly appointed Chairman Bernanke. Most of the media coverage of the Fed at the time was a celebration of the Maestro and his wise stewardship of the economy. Thus, there was almost no reporting or domestic criticism of the discontinuance of M3. There were many concerns expressed by sophisticated fund managers, analysts, and foreign investors (central banks). There was also one meek and humorous attempt by Congress to inquire into the M3 decision. Here is a wonderful snippet of Bernanke doublespeak from November 15, 2005:

Senator Bunning: The findings of the M3 report provide pertinent information to the public — from economists to investors and to industries which all use M3 report findings for economic forecasting, investing and business decisions. … Will you work to reverse this policy and commit to keeping the M3 report and its findings available and open to the public? What is the rationale and reasoning behind the Federal Reserve decision to keep the M3 information from the public?

Bernanke: The Federal Reserve will not withhold the M3 data from the public; rather, it will no longer collect and assemble that information.

 

Key Source of Research:

 

Death of M3: The Fifth Anniversary

2010

https://mises.org/library/death-m3-fifth-anniversary